Investor Demand for Industry Factor Price Exposure

Phil Davies, Bernadette Minton and Catherine Schrand
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Phil Davies: University of Iowa
Bernadette Minton: Ohio State University
Catherine Schrand: University of Pennsylvania

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: Market frictions make markets incomplete. Firms' equity securities can help to complete markets by offering investors opportunities to invest in assets that are otherwise unavailable or costly to acquire. However, stocks offer a substitute for the underlying assets only if the firm maintains exposure to the assets. In incomplete markets, investors should display preferences for stocks with high industry exposure, especially when the costs of direct investment in the industry assets are high. We provide evidence that investors display preferences for stocks with high industry exposure based on a robust positive relation between investor interest (turnover, and the number of institutions and mutual funds) and industry exposure. The association is unrelated to levels of diversification. The attraction to industry exposure is greatest in industries in which returns differ significantly from those of the aggregate market portfolio, where the benefits from investing in industry exposed stocks as substitutes for the underlying assets are the greatest. Preferences for industry exposure are most pronounced for transient investors investing based on public information, and sector funds seeking industry exposure.

Date: 2008-11
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